Abstract
The Federal Reserve has been assigned the goal of fostering financial stability along with its monetary policy goals of maximum employment and stable prices. This paper considers whether the financial stability and monetary policy goals have consistent policy implications both in theory and in practice. It also considers how the implementation of monetary policy might conflict with financial stability and vice versa.
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Notes
Mester (2016) argues that in general, the goals of monetary policy and financial stability are complementary.
The goals that have been and/or are currently assigned to the Federal Reserve includepromoting a more efficient payments system, enforcing consumer protection laws, and enforcing antitrust rules with regards to mergers by state member banks and bank holding companies.
See Mehra (2010).
As a part of this, Congress also assigned a third goal of “moderate long-term interest rates.” However, the Federal Reserve has taken the position that the monetary policy path consistent with meeting the dual mandate, especially stable prices, is the path most likely to result in moderate long-term interest rates over a longer horizon.
Arguably monetary policy cannot directly impact real economic variables in the long run. Rather growth is largely dependent upon population and productivity growth. What monetary policy can do is provide a stable macroeconomic and financial environment that allows the economy to achieve its growth potential.
An additional reason for maintaining a 2% inflation rate is that doing so reduces the risk that an adverse shock would result in deflation. Given that the effective lower bound on interest rates is near zero, the existence of deflation impedes the ability of the Federal Reserve to conduct monetary policy by limiting its ability to lower the real short-term interest rate.
This formulation of the goals of monetary and macroprudential policy arguably embeds a potential conflict between “maximum” and “sustainable” (or in statistical terms, between the first and second moment of the distribution of growth rates). However, as discussed below, estimating the links between policy and the first moments of the distributions is difficult enough. There is no widely accepted model linking policy actions to the second moment of the distribution.
As an example, Federal Reserve Bank President Kashkari recently noted that while banks should hold more capital as a cushion against possible economic shocks, too high standards could conflict with monetary policy goals by raising credit costs and reduce economic growth. http://www.reuters.com/article/us-usa-fed-kashkari-idUSKCN0Z61WJ
This could take the form of being asked to follow looser policies to foster growth and lower unemployment. Alternatively, it could take the form of being asked to follow stricter policies to help reduce the rate of inflation.
Svensson used a small parameter estimate to quantify the financial stability effect through only one channel (debt growth).
We do not know yet what the potential consequences of the Federal Reserve’s zero interest rate policies or the series of quantitative easing actions may have on the financial system and financial stability. The Fed has not yet unwound its large balance sheet and how that process proceeds will have important implications for asset prices, market liquidity and financial stability.
Anderson and Huther (2016) explain that the primary dealer participation in ON RRP is low because the dealers are typically net borrowers in money markets.
See Eisenbeis and Herring (2015).
See footnote 14 of Frost, et al. (2015, p. 14)
Dudley (2013).
JPMorgan Chase also failed to provide a credible living will plan. See https://www.federalreserve.gov/newsevents/press/bcreg/20160413a.htm.
See Mancini et al. (2015) for a discussion of the repo markets in Europe.
Currently, the Fed supervises The Clearing House Payments Company, L.L.C and CLS Bank International as FMUs while the SEC and CFTC supervise six other entities, mainly exchanges, that have been designated FMUs.
See Wall (2015b).
Branches of foreign banks are not subject to FDIC deposit insurance assessments as their deposits are not insured by the FDIC. These branches are subject to minimum capital to total asset requirements through the application of Basel III to their parent bank’s consolidated balance sheet. However, thus far many foreign supervisors use quarter-end total assets for this requirement whereas the U.S. authorities use the quarter average total assets. Thus, foreign banks can avoid the capital charges by shedding their excess reserves at quarter end.
See Frost, Logan, Martin, McCabe, Natalucci, and Remache (2015).
Each of the agencies’ websites contains a description of how they perceive their mission. As of February 2017 these descriptions varied across the agencies. The Commodity Futures Trading Commission, Federal Deposit Insurance Corporation, and Federal Reserve’s discussion of their mission directly references stability of the “financial system” or to “avoid systemic risk”. The National Credit Union Association, and Office of the Comptroller of the Currency discusses the “safe and sound” operation of the institutions they regulate. The Federal Housing Finance Administration states the goal of the keeping the “overall housing finance system” healthy. The Securities and Exchange Commission overview of its mission does not list stability but it does state that one of the reasons for its creation is to promote “stability in markets.” Finally, the Consumer Financial Protection Bureau has no references to the stability of financial institutions, markets or the overall system.
See Mester (2016).
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The authors are respectively, Vice Chairman, Cumberland Advisors; Senior Research Advisor, FRB San Francisco; and Executive Director, Center for Financial Innovation and Stability, FRB Atlanta. The views expressed are those of the author and do not necessarily reflect those of Cumberland Advisors, the Federal Reserve Banks of Atlanta, the Federal Reserve Bank of San Francisco, or the Federal Reserve System. The authors thank their anonymous referee, Ron Feldman and participants at the conference “The Interplay Between Financial Regulations, Resilience, and Growth” for helpful comments.
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Eisenbeis, R.A., Kwan, S. & Wall, L. Financial Stability and Resolution of Federal Reserve Goal and Implementation Conflicts. J Financ Serv Res 53, 163–178 (2018). https://doi.org/10.1007/s10693-018-0297-6
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DOI: https://doi.org/10.1007/s10693-018-0297-6